What causes deficits?

April 14, 2011 —

“Annual income twenty pounds, annual expenditure nineteen pounds nineteen and six, result happiness. Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.” With these words, Charles Dickens’ irrepressible but perennially indigent Mr. Micawber sets out a crucial principle that apparently escapes the current-day deficit-hawks in Washington: that debt arises not from one thing, but from a relationship between two things—income and spending. A loss of income can produce a deficit just as readily as an excess of spending. And the very act of cutting spending can trigger a loss of government income by putting the brakes on economic activity, the underpinning for all income in the country, public as well as private.

As long as the American economy continues sluggish, the deficit problem will never be solved. And while it is sluggish, every cut in government spending—like last week’s orgy of budget-slashing, which Republicans and President Obama alike toast as “the largest in history,” will only result in a further loss of income, used as an excuse for further cuts in spending, in an unending, impoverishing vicious cycle.

History teaches us that government can spend the money needed to create and maintain our common infrastructure, educate our workforce, protect our environment, encourage technological innovation and take care of the vulnerable among us—“expenditures” most of which are in fact also investments, necessary for future income generation—without crippling the economy. The $290.4 billion deficit inherited by Bill Clinton, for instance, was turned into a surplus of $236.4 billion, due largely to a booming economy: higher private income means more tax income. But some of it was due to the fact that government raised some tax rates, largely on upper-income households—proving that you can raise taxes without harming the economy, if you do it in the right place.

History also teaches us that cutting government spending when the economy is weak can actually create recessions and reduce government income. That’s what happened to Franklin Roosevelt in 1937 when, after several years of successful New Deal programs helped reverse the economic decline of the Great Depression, he was persuaded by the deficit hawks of his day he had to cut spending. Back down the economy went.

The reason rising government debt is said to be a threat to economic recovery is that, in theory, government demand for money makes interest rates go sky-high, impeding the flow of credit to businesses. But that’s just not the case currently. On the contrary, interest rates hover at record lows, impoverishing people on fixed incomes who rely on interest income, while enriching banks who can borrow practically for free from the government. In fact, all corporations have prospered in this cheap money environment, pushing the cost of investment toward zero. The problem is that they’re not using that cheap money to invest in the U.S. or hire U.S. workers.

Worker productivity increased by 2.6 percent in the fourth quarter of 2010, while real hourly compensation dropped. Unemployment remains at levels normally associated with recessions. Tax income from workers suffers accordingly. Meanwhile corporate profits grew 36.8% in 2010, the biggest gain since 1950—and how much of that goes into taxes? Corporate taxes accounted for 35% of all federal revenues in 1945, but less than 9% in 2010, as corporations wangle better and better deals for themselves from increasingly compliant Congressmen.

Money is also being funneled increasingly to the top one percent of households that now takes home almost one quarter of the national income. That’s another hit to tax revenues, as the proportion they contribute to taxes has declined dramatically. The cost of the Bush tax cut for the top two percent of income earners, extended last year, is estimated at $700 billion over 10 years. Having thus looted the treasury for the very rich, deficit hawks are now using the shortfall as an excuse to axe programs that support the middle class and poor.

Meanwhile, Obama and many Democrats have shamefully acceded to the misguided narrative that government spending is responsible for the current economic malaise and that spending cuts are a solution rather than a problem. And the cutting isn’t over; the Republicans plan another showdown when the debt ceiling comes up for a vote a few weeks from now.

There’s no leadership in Washington, and if things are going to change, the grassroots are going to have to make it happen. We need to tell our representatives to stop cutting the legs out from under the economy. It’s time to spend money in a way that will help American Main Street businesses and households regain their vigor—and yes, to raise taxes in a way that will make the big multinational corporations and the wealthy elite shoulder their fair share.